The Reasonable Probability Increment Continues to Boost Just Compensation For Wetlands Condemnation in Galarza v. City of New York

Early this year, the Supreme Court of New York, Richmond County issued a comprehensive opinion in Galarza v. City of New York, 58 Misc.3d 1210(A), reaffirming and clarifying the nuances of condemnation, takings and just compensation principles as they relate to wetlands restrictions. The court held that the owner of a 21,000 square-foot vacant lot (“Property”) condemned by the City of New York (“City”) as wetlands was entitled to just compensation in the amount of $669,000, where the fair market value of the undevelopable land was approximately $200,000.

In awarding upwards of 335% of the Property’s apparent value, the court found that the owner was entitled to an incremental increase in just compensation. This finding was based upon the nature of the wetlands restrictions vis-à-vis takings precedent. And, it is significant that the court awarded the higher value despite the owner having purchased the Property after it was already designated as wetlands and known to be undevelopable. This decision follows a late-2017 decision of the Appellate Division in In re New Creek Bluebelt Phase 3 (Baycrest Manor), 156 A.D.3d 163 (2d Dep’t 2017), where the Second Department affirmed, as modified, an increased award as just compensation for wetlands condemnation.

Claimant Ivan Galarza (“Owner”) purchased the Property at a tax lien foreclosure auction in 2003. At the time the Owner purchased the Property at auction, the Property was already designated as wetlands. The City later acquired the Property by condemnation as part of its New Creek Bluebelt Phase 4 project. The Owner and the City both agreed that the wetlands designation precluded the Owner from obtaining a permit to improve the Property and that the highest and best use of the Property, as regulated, would be to remain vacant. The parties disagreed, however, as to whether the wetlands restrictions constituted a regulatory taking. The regulatory taking issue is relevant and forms the crux of this entire case because it is precisely the finding of a “reasonable probability of success” in bringing a hypothetical regulatory taking claim to challenge regulations, e.g. wetlands restrictions, that entitles a property owner to the incremental increase in just compensation.

The Threshold Question: Whether the Regulation Is a Background Principle of New York State Law on Property and Nuisance

First, the court addressed the threshold issue of whether the Owner was barred from bringing a takings claim in the first place, because the Owner purchased the Property subject to the wetlands designation. Relying on Lucas v. South Carolina Coastal Council, 505 U.S. 1003 (1992), Galarza stated that the “logically antecedent inquiry” into a takings claim is whether “the proscribed use was part of the title to begin with.” Thus, before any owner can claim deprivation of economically beneficial uses of property, courts must first determine whether the right to use the property in the manner prohibited was actually part of the “bundle of rights” acquired with title.

In Lucas, the U.S. Supreme Court held that in order for a regulation not to constitute a taking where it prohibits all economically beneficial use of land, the regulation cannot be newly legislated or decreed, but must inhere in the title itself; the restriction must be a background principle of a state’s law of property and nuisance – already placed upon the ownership of property. After Lucas, the New York Court of Appeals issued four opinions simultaneously in 1997 known as the “takings quartet.”[1] These four cases established the “notice rule” in New York, whereby any owner who took title after the enactment of a restriction was barred from challenging the restriction as a taking because the use prohibited was not part of the bundle of rights acquired with title by a buyer.

Almost a decade after Lucas, the U.S. Supreme Court’s decision in Palazzolo v. Rhode Island, 533 U.S. 600 (2001), up-ended New York’s “notice rule.” The high Court held that a per se notice rule was untenable and altered the nature of property because an owner would be deprived of the right to transfer an interest acquired with title (prior to the regulation). Moreover, the Court held that simply because an owner acquired property after the enactment of regulations does not transform those regulations into background principles of state law on property and nuisance.

In determining whether New York State’s wetlands restrictions affecting the Property are part of the background principles of New York’s law on property and nuisance, the Galarza court answered in the negative. Interestingly, the City argued, among other things, that protection of wetlands was grounded in common law and cited to medieval England’s use of wetlands restrictions. The court noted, however, that these restrictions pre-dated the creation of fee estates and that as individual ownership rights began to take shape, wetlands regulations were abandoned in favor of development.

In addition, the Galarza court distinguished the Palazzolo decision issued by Rhode Island Superior Court after remand from the U.S. Supreme Court. The Superior Court found that wetlands designations were part of the background principles of Rhode Island’s state law. Conversely, the Galarza decision found that “[w]hile development of wetlands constitutes a nuisance under Rhode Island law, development of wetlands was not a nuisance under New York law.” The court chronicled the filling and draining of wetlands and the history and treatment of land development in the City from its inception until the 1970s, at which time conserving wetlands became a concern. “Given this history, it is clear the New York wetlands regulations did not simply make explicit a prohibition on activity that was always unlawful, and therefore the wetlands regulations are not part of New York property and nuisance law.”

The Galarza court also distinguished a 2016 Second Department ruling in Monroe Eqs. LLC v. State of New York, 145 A.D.3d 680, which held watershed regulations constituted background principles of New York law. Unlike wetlands regulations, watershed regulations prohibit a nuisance by preventing poisoning and pollution of water supplies and drinking water. Based upon this analysis, the court found the Owner in Galarza was not barred from bringing a takings claim.

The Regulatory Takings Analysis: Per Se, Partial or Not at All

After having found the Owner’s regulatory taking claims were not barred, the court proceeded to the crux of the case: whether there was a reasonable probability that the wetlands regulations constituted a regulatory taking. If not, the Owner’s just compensation is limited to the value of the Property as regulated. If so, then the Owner is entitled to an incremental increase in value as just compensation, i.e. the value of the land as restricted plus an increment. The increment reflects the premium a hypothetical buyer would pay for the Property in light of the probable success on a takings challenge. (In other words, the Property would be worth more and, thus, entitled to greater value as just compensation for condemnation.) To show a reasonable probability of success on a takings claim, the claimant must demonstrate that the regulation renders the property “unsuitable for any economic or private use, and destroy[s] all but a bare residue of its value.”

To determine whether there was a reasonable probability of a successful regulatory takings claim, the court considered Lucas, Tahoe-Sierra Preserv. Council, Inc. v. Tahoe Regional Planning Agency, 535 U.S. 302 (2002) and Penn Central Transp. Co. v. City of New York, 438 U.S. 104 (1978). Under Lucas, a regulation constitutes a taking per se “only in the extraordinary circumstance where no economically beneficial use of the land is permitted and the regulations have extinguished all of the property’s value.” In this scenario, no further analysis is necessary. Galarza highlighted the distinction between “economic use” (returns from actual use or development) and a “property’s value” (market value as regulated or otherwise), but noted that Lucas used these terms interchangeably. Later, the U.S. Supreme Court clarified Lucas in Tahoe-Sierra : “compensation is required when a regulation deprives the owner of all economically beneficial uses of his land…[and] is limited to the extraordinary circumstance when no productive or economic beneficial use of land is permitted.” Anything short of 100% loss of value is not a regulatory taking per se and requires additional analysis by the factors enumerated in Penn Central.

Specifically in Galarza, the Property had value as regulated because there is a market for wetlands in Staten Island (discussed below), but the Property had no economic beneficial use. The court considered two other cases in this respect, namely Lost Tree Vill. Corp. v. United States, 787 F.3d 1111 (Fed. Cir. 2015), and Florida Rock Indus., Inc. v. United States, 18 F.3d 1560 (Fed. Cir. 1994), to determine whether having value without any beneficial or economic use(s) precludes a taking per se. The court in Lost Tree, on the one hand, held that residual non-economic value (i.e. market value) does not preclude a per se taking because there are no longer any underlying economic uses and the market value (selling the property) is not an underlying economic use. Florida Rock, on the other hand, held that the value of property as a speculative investment is a proper consideration and that the associated market value precludes finding per se taking.[2]

The court in Galarza agreed with Florida Rock, holding that there is an established market for wetlands in Staten Island (for reasons that are not entirely clear) and that these parcels are bought and sold with an expectation that the restrictions may eventually be changed, waived or modified, or that the parcels might be sold at a profit. Regardless of the motives and intentions, this market exists for parcels without permissible uses and this market must be considered in the takings analysis. The Property was found to have a market value of $200,000. Accordingly, because the Property has value in this market, the wetlands designation does not deprive the Property of all of its economic value (although it does deprive economic use entirely). Therefore, it cannot qualify as a regulatory taking per se under Lucas.

Having failed to meet the Lucas test, the court then turned to a partial regulatory takings analysis under Penn Central. This analysis is an “ad hoc, factual inquiry” and considers three factors: (1) the regulations’ economic impact upon the claimant, (2) the extent of interference with “reasonable” investment-backed expectations and (3) the character of the regulation as governmental action.

Penn Central Test Part 1: Economic Impact

First, in evaluating the economic impact, courts must compare the value that the regulation has taken from the property with the value that remains with the property. Here, the court analyzed precedent set by four previous Second Department cases in wetlands taking cases (ranging from 1984 through 2017).[3] Based upon these cases, the Galarza court found there was a reasonable probability of a successful regulatory takings challenge where regulations deprived the claimant of all rewarding uses of the property, e.g. development prohibition, and reduced the property’s value upwards of 80-90%.

In contrast, the court cited two other Second Department cases: Adrian v. Town of Yorktown, 83 A.D.3d 746 (2d Dep’t 2011), and Putnam County Nat’l Bank v. City of New York, 37 A.D.3d 575 (2d Dep’t 2007). In Adrian, the court did not find a regulatory taking where the property value was reduced by a 64% reduction and the claimant sold the 15-acre parcel for $3,600,000, although contended it was worth $10,000,000. In Putnam County Nat’l Bank, the court also did not find a regulatory taking. There, watershed regulations reduced the value by 80%, and although the claimant was denied a building permit for a 36-lot subdivision because a sewer could not be built within the watershed, approval was granted for an alternative 17-lot subdivision. The property was ultimately sold for $1,400,000. That court found this realization was a “reasonable return”, and the economic impact of the watershed restrictions was not sufficient to constitute a taking.

Here, after various arguments and evidence presented by the parties, the court found the Property to have the following set of values: $200,000 as regulated and undeveloped and $1,701,000 as fully developed. The court also found that it would cost $469,507 to develop the Property and, when the costs are deducted from the fully developed value ($1,701,000 less $469,507), the value of the return would be $1,231,493. The difference, then, between the regulated value ($200,000) and the developed value, after costs ($1,231,493), is $1,031,493. This figure is 84% of the fully developed value. Another way to view the calculation is that the regulated value ($200,000) is 16% of the fully developed value. Accordingly, the regulations reduce the Property’s value by 84%.

Penn Central Test Part 2: Extent of Interference with Expectations

Penn Central’s second factor is the extent of interference with investment-backed expectations. Initially, courts must determine whose expectation to use. In the regulatory takings context, the expectation of the owner is used because it is his or her land that suffers from the restraint. To determine just compensation in the condemnation context, the expectation of the hypothetical buyer is used because this perspective determines the owner’s realization upon a sale.

Considering the hypothetical buyer’s expectations, the court must view the reasonableness of the expectation as an objective test: whether the regulation embodied a background principle of New York property and nuisance law. This is the same consideration in determining whether a regulatory claiming is barred at the outset. Essentially, it is unreasonable to expect to use property in such a manner prohibited as a background principle of law. Finding guidance from the U.S. Supreme Court in Palazzolo, Galarza concluded it is reasonable to expect to utilize property as if the regulations did not exist – unless the regulations are background principles, the analysis cannot begin by limiting expectations to only those uses allowed by the regulation if the regulation is not a background principle.

As noted above, the Staten Island wetlands market exists and contemplates that regulations may be changed, waived or modified in favor of future development. The court here ultimately determined it is not unreasonable for a hypothetical buyer to expect to develop the Property at some future date because, among other things, the wetlands restrictions are not background principles of law. Accordingly, because any development was totally prohibited by the wetlands designations, then the regulations substantially interfered with reasonable expectations to develop the Property.

Penn Central Test Part 3: Character of the Regulation

The third factor under Penn Central is the character of the regulation. Courts consider whether it amounts to a physical invasion or, instead, merely affects property interests. Additionally, courts consider “reciprocity of advantage,” i.e. whether the regulation is part of a general scheme that provides some benefit to the regulated parcel, like a comprehensive zoning plan. The singling-out of a parcel with a disproportionate burden is indicative of a taking. The Galarza court found that while wetlands restrictions provide a benefit to the public in general, their burden falls disproportionately on a small group of owners, especially those whose entire parcels are classified as wetlands (as opposed to portions of parcels or parcels that are wetlands adjacent). Here, the wetlands regulations approach a physical taking because they prohibit development entirely and force the Owner to leave the Property vacant.

Concluding Penn Central

In concluding its Penn Central analysis, Galarza found: (1) the wetlands regulations diminished the value of the Property by 84%, (2) interfered with the reasonable expectations of the Owner or a hypothetical buyer to develop the Property and (3) the character of the regulations is disproportionately burdensome and prohibits all economic use of the Property. Moreover, the court found that the diminution of value was so great and the prohibitive character so invasive that, even if a hypothetical buyer did not have an expectation to develop, the regulations themselves “nearly approximate a physical appropriation as to constitute a taking under a Penn Central analysis.”

Therefore, the court held just compensation valuation must include the regulated value plus the incremental value to reflect the hypothetical buyer’s likelihood of successfully challenging the wetlands regulations as a regulatory taking. This increment is a portion of the difference of the valuation over-and-above the regulated value. Here, the regulated value was $200,000 and the developed value, after costs was $1,231,493; the difference between these figures is $1,031,493, and the increment is a portion of this difference. (The Owner already receives the regulated, fair-market value as just compensation, so this value is not included in increment calculation).

In determining the actual incremental value, courts consider the time, effort and expense in “de-regulating” the affected land, including without limitation exhausting administrative remedies, prosecuting the takings challenge and the financial cost of “carrying” the affected property. Here, the court found that the deregulation costs would be $391,882 and deducted these costs from $1,031,493, resulting in a “present day value” figure of $639,611. The present day value figure must be discounted for inflation and opportunity costs, among other things. The court determined that the present day value after the applied discount was $469,380 – and this is the incremental value to be applied. Finally, the court completed its calculation for its award of just compensation: it added the regulated value ($200,000) together with the increment ($469,380), resulting in an award of $669,380 (rounded to $669,000).

—ENDNOTES—

[1] The four cases are as follows: Gazza v. New York State Dep’t of Envt’l Conserv., 89 N.Y.2d 603 (1997), Basile v. Town of Southampton, 89 N.Y.2d 974 (1997), Anello v. Zoning Bd. of Appeals, 89 N.Y.2d 535 (1997), and Kim v. City of New York, 90 N.Y.2d 1 (1997). Gazza and Basile addressed wetlands restrictions.In determining the actual incremental value, courts consider the time, effort and expense in “de-regulating” the affected land, including without limitation exhausting administrative remedies, prosecuting the takings challenge and the financial cost of “carrying” the affected property. Here, the court found that the deregulation costs would be $391,882 and deducted these costs from $1,031,493, resulting in a “present day value” figure of $639,611. The present day value figure must be discounted for inflation and opportunity costs, among other things. The court determined that the present day value after the applied discount was $469,380 – and this is the incremental value to be applied. Finally, the court completed its calculation for its award of just compensation: it added the regulated value ($200,000) together with the increment ($469,380), resulting in an award of $669,380 (rounded to $669,000).

The cases that hold that one cannot consider speculative uses in valuing property in condemnation cases refer to non-current uses where it is not probable that the property would be put to such a use in the reasonable near future. This is different from investors who speculate in property by purchasing it on the possibility of expectation that it will increase in value at some point in the future. In this [latter] sense, speculative purchases represent investment backed expectation.

In addition, the court noted that dollars are fungible and that the land-speculation market provides owners with monetary compensation the same way as any other market. Moreover, the key inquiry for purposes of just compensation for condemnation is whether there was a reasonable probability of successfully bringing a takings challenge as of the date of vesting – not whether any expectations of future value might be met.